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The Case For Not Worrying About Inflation

Paul Krugman argues that inflationary fears are overstated. There are, he says, two main reasons to worry about inflation. First, the Federal Reserve is printing money:

[I]t’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.

Still, don’t such actions have to be inflationary sooner or later? No. The Bank of Japan, faced with economic difficulties not too different from those we face today, purchased debt on a huge scale between 1997 and 2003. What happened to consumer prices? They fell.

Printing money, in other words, doesn't matter if the money never makes it into the economy. And according to Krugman, that's what's happening now. But what happens when banks begin lending again?

Second, says Krugman, federal debt might rise to 100 percent of GDP:

Is there a risk that we’ll have inflation after the economy recovers? That’s the claim of those who look at projections that federal debt may rise to more than 100 percent of G.D.P. and say that America will eventually have to inflate away that debt — that is, drive up prices so that the real value of the debt is reduced.

Such things have happened in the past. For example, France ultimately inflated away much of the debt it incurred while fighting World War I.

But more modern examples are lacking. Over the past two decades, Belgium, Canada and, of course, Japan have all gone through episodes when debt exceeded 100 percent of G.D.P. And the United States itself emerged from World War II with debt exceeding 120 percent of G.D.P. In none of these cases did governments resort to inflation to resolve their problems.

By Ezra Klein  |  May 29, 2009; 1:00 PM ET
Categories:  Economic Policy  
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Comments

Other recent posts by economists are consistent with this "don't worry about inflation" view. See http://thefinancebuff.com/2009/05/the-have-no-fear-inflation-update.html

Posted by: TheIncidentalEconomist | May 29, 2009 2:10 PM | Report abuse

Obviously, Krugman is right. But also, why exactly would a nation of net debtors fear inflation?

Heck, on housing inflation is a great solution to our current problem. My mortgage payments are huge now, but with inflation they'd stay the same and I'd get paid more. And my home's worth would go up in rough pace with inflation.

I see where rich people and the banks who are holders of debt are terrified of inflation. But, most people are debtors. For them, inflation would be a good thing and make their debt a smaller percentage of their take-home pay.

Of course, I'm assuming wages won't continue to stagnate, which might be a stupid thing to do...

Posted by: theorajones1 | May 29, 2009 2:15 PM | Report abuse

But these aren’t ordinary times. Banks aren’t lending out their extra reserves.

The problem with Krugman's posts, as usual, is he tells you only half the story.

He says that it doesn't matter how much money is in the system because the velocity, a multiplier, is low in tough economic times. What he doesn't tell you is that when the economy picks up and the velocity, the rapidity with which money turns over, also increases, it will have a devistating inflationary effect unless tmoney supply is then reduced which means high interest rates and the Obama administration won't have the balls to squelch the new economic growth he will be taking credit for. He will, instead, make minimal efforts until he is out of office and kick the can down the road to the next president.

Posted by: ElViajero | May 29, 2009 8:58 PM | Report abuse

"But these aren’t ordinary times. Banks aren’t lending out their extra reserves."

The problem with Krugman's posts, as usual, is he tells you only half the story.

He says that it doesn't matter how much money is in the system because the velocity, a multiplier, is low in tough economic times. What he doesn't tell you is that when the economy picks up and the velocity, the rapidity with which money turns over, also increases, it will have a devistating inflationary effect unless tmoney supply is then reduced which means high interest rates and the Obama administration won't have the balls to squelch the new economic growth he will be taking credit for. He will, instead, make minimal efforts until he is out of office and kick the can down the road to the next president.

Posted by: ElViajero | May 29, 2009 8:59 PM | Report abuse

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